On occasion I have discussed the kinds of returns that have been achieved by investing in the stock and bond market. For example, the stock market over many years has averaged annual returns of close to 10% per year. However, future returns could be somewhat lower. Unfortunately, most investors do not achieve the returns of the market averages.
The term average essentially refers to just a midpoint. In a league of sports teams, the average for the league will be 50% wins and 50% losses, though individual teams will do better or worse than the averages.
Likewise, for investors and investment managers, some will do better than others. What is surprising to many is that most individual investors tend to perform significantly worse than the market averages.
There are several reasons why investors tend to do worse than the market averages. The key reasons are overconfidence, unnecessary fear, lacking a disciplined investing approach, and unnecessary fees and trading expenses.
When it comes to investing it is easy to second guess oneself. Someone might think, if only I had bought at this time and later sold, I could have done extremely well. Unfortunately, even the so-called “experts” cannot accurately predict the future, so it is not too likely that an uninformed investor will do better than professional investors.
An individual investor could be doing very well for a short period of time by taking risky bets. This success can easily lead to overconfidence, but at some point a portfolio with a heavy concentration in one industry will perform poorly.
Fear is something we all have to contend with, but some people can handle it better than others. The best way to combat fear is to have a good understanding of the risks involved with investing. Some people think the stock market is one big casino, and half the time it goes up and the other half of the time it goes down. This might be true on a day-to-day basis, but over long periods of time the stock market has done very well.
Likewise, investors need to understand that corrections periodically occur. Oftentimes, when corrections happen people panic and do not want to be invested. This causes investors to have an excessive amount of money in a savings or money market account. Normally the largest percentage gains in the stock market occur, when it is recovering from a market bottom, but unfortunately the fearful investor is missing out on these gains.
Too many investors either lack an investing plan, or if they have one, fail to stick to it. Many people only want invest in the stock market when it is going up, and try to be out of it when it is dropping. Unfortunately, this type of timing seldom works. It is important that investors have a targeted amount, or a range for various investments, and stick to the plan.
A young person should have the bulk of their retirement money in the stock market, because they have a long-term investment horizon, and can recover from periodic has a smaller percentage in risky assets, like the stock market.
Fees are something that investors need to be aware of, since that will impact overall performance. When investing in various investment funds in a retirement account, an investor should be aware of the annual expense ratio. An index fund will have significantly lower fees versus a fund that is actively managed.
Outside of retirement accounts investors will pay fees, if they use an investment advisor. These fees can be a combination of management fees, or costs based on transactions. For some investors having an investor advisor is worth paying the added fees, but investors need to be aware of how much the fees are and not overpay.
People generally want to do better than being average, but in the investment world achieving the market averages is normally a good thing. In retirement accounts there are some unavoidable fees, but sticking with a disciplined investment plan will enhance performance over time.
